Principles of Accounting

Question 1

Define accounting

Answer 1

The process of identifying, measuring and communicating info to permit informed judgements and decisions by users of the info

Question 2

Purpose of accounting

Answer 2

to discharge the accountability function of management & to influence the decisions of those who . use the info provided

Question 3

2 fundamental qualitative characteristics of accounting

Answer 3

1. relevance (must be able to influence decisions/be predictive/confirmatory value)
2. Faithful representation (complete, neutral and free from error)

Question 4

4 Enhancing qualitative characteristics

Answer 4

VUCT

• Verifiability (independent observers would come to the same conclusion)
• Understandability (clear, concise to users of the info)
• Comparability (across time periods to id simlarities/differences within and across an entity)
• Timeliness (must be produced in time to aid decision making)

Question 5

Financial v Management accounting

Answer 5

Financial: Income statement, balance sheet, cash flow statmeent (external user focus)
Management: Planning & budget, costs, pricing (internal user focus)

Question 6

Outline the accounting process

Answer 6

1. Business transactions occur
2. Entered into accounting info system which are then turned into special purpose management reports or special purpose reports for tax returns + other reports for gov agencies.
3. Or they become general purpose reports (income, balance, cash flow)

Question 7

Conceptual frameworks of financial reporting - the principles of accounting

Answer 7

1. entity concept
2. Accounting time period concept
3. Cost principle (historic)
4. Matching principle (expenses recorded in same accounting period as the respective revenues, regardless of when the transfer of cash occurs- for accrual acc only)
5. Profit recognition principle
6. The conservatism (prudence principle)
7. The going concern principle

Question 8

3 main types of financial report

Answer 8

1. Statement of cash flows
2. Income statmenet (Statement of financial position)
3. Balance Sheet (Statement of financial performance)

Question 9

1. Statement of cash flows

Answer 9

shows inflows & outflows of cash for the period + opening & closing balance

Question 10

2. Income statmenet (Statement of financial position)

Answer 10

measures profit made in a period (profit= revenues- expenses)
Stock of wealth at a point in time

Question 11

3. Balance Sheet (Statement of financial performance)

Answer 11

show’s a business’s assets & claims on those assets. (claims always relate to external liabilities)
Flows of wealth over time

Question 12

Accounting Equation

Answer 12

Assets= liabilities + OE

Question 13

OE accounts

Answer 13

Capital, drawings, revenues, expenses, dividends

Question 14

The entity concept

Answer 14

states the business activities & personal affairs of the owner are separate

Question 15

Accounting time period concept

Answer 15

Defines the unit of time that accounting data is collected & financial statements prepared usually end year on 30 June

Question 16

Cost principle

Answer 16

states that assets and services acquired must be required at their actual cost when purchased. (achieves reliability and objectivity)

Question 17

Matching principle (for accrual accounting only)

Answer 17

Expenses must be recorded in the same accounting period as the respective revenues, regardless of when the transfer of cash occurs (vs opposite–> cash basis of accounting)

Question 18

Financial objectives of a business?

Answer 18

to enhance the wealth of owners - risks levels associated with the business must be balanced with the required return

Question 19

return vs risk

Answer 19

return= gain resulting from particular event
risk= likelihood that what's projected won't actually occur

Question 20

Short term gains can lead to

Answer 20

long term problems –> GFC (securitisation of loans were separated from original human origin and sight of the big picture was lost from greed & poor stewardship)

Question 21

Revenue/profit recognition principle

Answer 21

states that one should only record revenue when it has been earned, not when the related cash is collected

Question 22

conservatism/prudence principle

Answer 22

is the general concept of recognising expenses and liabilities as soon as possible when there is uncertainty about the outcome, but to only recognise revenues and assets when they are assured of being received.

Question 23

Going concern principle

Answer 23

where accountants assume that the business will continue operating for the foreseeable future.

Question 24

Why do we have the going concern principle?

Answer 24

If going concern principle wasn’t the case:
—> the business would have to convert all assets to cash based on current market value, instead of just reporting assets & liabilities on the basis of cost adjusted where appropriate for specific values

Question 25

Sole proprietorship- definition + features

Answer 25

single owner in business on their own account.

• separate accounting entity
• one legal entity (no distinction–> the legal owner enters into contracts, sole proprietor is personally liable )
• life span: limited by owner’s choice or death
• minimum reporting regulations
• easy to set up
• limited no. owners

Question 26

definition + features partnership

Answer 26

Partners : 2+ owners carrying on a business for profit

• separate accounting entity (partnership is separate from the individual partners)
• one legal entity (partners are personally liable)
• Life span: limited by owners’ choice/death
• greater reporting regulations –> Partnerships Act gives direction for responsibilities
• simple to form
• limited membership (of 20 usually)

Question 27

definition + features shareholders

Answer 27

Shareholders, usually many

• separate accounting entity ( of company from the shareholders)
• separate LE, CEOs are liable, but shareholders not personally liable
• Life span: indefinite (easy transfer of ownership)
• Extensive government regulations
• Very tricky to set up (apply to ASIC, need ABN, board of directors)
• Unlimited no. members

Question 28

Advantages of sole proprietorship

Answer 28

1) easy to set up/operate
2) minimum financial reporting regulations
3) ownership & management normally combined (total undivided authority)
4) All financial rewards —> 1 owner
5) timely decision making

Question 29

Advantages of Partnership

Answer 29

1) greater access to capital
2) partners bring different skills
3) greater management flexibility
4) Tax advantage since income spread btw partners

Question 30

Advantages of Limited Company

Answer 30

1) separate legal entity
2) limited liability of shareholders
3) easy transfer of ownership

Question 31

Disadvantages of sole proprietorship

Answer 31

1) unlimited legal liability
2) restricted access to capital
3) limited experience/knowledge
4) limited access to non-ownership funding

Question 32

Disdvantages of Partnership

Answer 32

1) unlimited personal liability for partners
2) need partnership agreement to prevent future problems
3) mutual agency, exposed to greater responsibility (you’re responsible for other partner’s actions)
4) reduced decision making authority

Question 33

Disadvantages of Limited Company

Answer 33

1) separate ownership and control

2) extensive gov regulations

Question 34

Difference between cash and accrual accounting

Answer 34

In cash accounting, the transaction is only recognised if it involves an immediate cash inflow/outflow.
For accrual based accounting, the cash system is extended to include a variety of non-cash transactions ie credit extended to or by the entity.
-> employs a wider criteria to decide whether revenue has been realised or expense has incurred.

Question 35

Analysis of accrual based accounting

Answer 35

employs a wider criteria to decide whether revenue has been realised or expense has occurred.
BUT as test other than cash flows are less easy to define, some certainty + objectivity is lost

Question 36

Analysis of cash based accounting

Answer 36

Cash flows are useful to recognise, however don’t give a satisfactory measure of the performance of the enterprise.

Question 37

Differnece btw ledger and journal

Answer 37

The Journal is a book where all the financial transactions are recorded for the first time. When the transactions are entered in the journal, then they are posted into individual accounts known as Ledger. The Journal is a subsidiary book, whereas Ledger is a principal book